Summary: Hong Kong, expected to be one of the world’s lowest tax jurisdictions for aircraft financing and leasing; Low tax profit concessions – BEPS compliant; transparent criteria for tax concessions, indiscriminate application – level playing field; Effective application to existing Aircraft financing and leasing structures including JOLCO structures (relating to funding leases).
The Inland Revenue (Amendment) (No. 3) Ordinance 2017 was adopted in July 2017 with a view to encouraging the use of Hong Kong as a jurisdiction of choice for aircraft leasing. It was framed with reference to common leasing and financing structures customarily used in aircraft leasing worldwide – including JOLCOs. The resulting HK tax regime for aircraft leasing is therefore well designed to be incorporated into or accommodate those structures subject to an overall requirement that the contractual framework should be compliant with regulations concerning harmful tax practices - tax base erosion and profit shifting (BEPS).
Compliance with BEPS principles is largely ensured by the HK scheme’s requirements around the need for the leasing entity to show that its central management and control is within Hong Kong. Discussions about what substantive elements will constitute sufficient central management and control continue with the Hong Kong Inland Revenue Department (HKIRD) but for the purposes of this briefing we assume that the HK lessor will have the requisite substance in HK
One of the elements that allows a HK lessor to be incorporated into common aircraft leasing structures is the relatively flexible application / interpretation to the term of “ownership”. The scheme does not require the HK lessor to be the legal owner of the aircraft – it is sufficient that it holds economic ownership in the aircraft. To comply with the scheme any arrangement/lease – referred to generically as a “funding lease” must: (a) satisfy one of the following criteria: (i) that it would be classified as a finance lease or a loan under HK GAAP or IFRS, (ii) the NPV of lease payments represent at least 80% of the fair market value of the aircraft; or (iii) the term of the lease is at least 65% of the remaining useful life of the aircraft; and (b) include provisions which ensure that title in the aircraft will or may pass to the HK lessor at the end of the lease term.
Application of JOLCO structures to Funding Leases
You may immediately see how this flexibility could allow a HK lessor to be integrated into a JOLCO structure. Legal ownership of the aircraft will be vested in the usual Japanese ownership structure and a lease then entered into with the HK lessor. The key tax/accounting issue will be to ensure that such lease satisfies both the Japanese criteria for an operating lease and the HK criteria for a “funding lease”.
It should be noted that the HK scheme requires that the HK lessor leases to an “aircraft operator” so it is not (in principle) possible for there to be a chain of leases between the HK lessor and the aircraft operator. HKIRD is aware of structures that use multiple layers of leases and is in principle open to be persuaded that they should be disregarded for the purposes of the rule if they have not been entered into for purposes which would be contrary to BEPS principles. The following structure diagram sets out a typical structure JOLCO structure applying to “funding leases”
The benefit for a leasing company to structure a JOLCO through an eligible HK qualifying aircraft lessor are the very significant tax benefits which the HK lessor enjoys on its revenue (an effective tax rate of 8.25% on 20% of the tax base) and the exemption from capital gains tax on disposal if ownership is held for more than 3 years. The obligation under the tax scheme to pay an amount of income tax (however reduced) every year, the lack of an extensive network of double taxation treaties and HK not yet having acceded to the Cape Town Convention remain the key concerns with using a HK entity as lessor.